Western Europe August 29, 2022 / 09:36 am UTC

ECB Hawkish Push 75bps, but

By Mike Gallagher

Bottom line: More ECB hawks over the weekend have highlighted that they want the ECB to discuss a 75bps hike on September 8.However, the ECB staff forecasts will need to shift to project a recession, while sovereign spread widening is amplifying a tightening of financial conditions and core inflation pressures could be peaking (here). Overall, we look for a 50bps hike in official rates in September. 

Figure 1: 10yr Breakeven Inflation (%)

Source: Continuum Economics, Bloomberg 

ECB Hawks Push 75bps Option 

The ECB hawks have followed through on a Reuters source story on Friday that a 75bps hike should be an option for discussion at the September 8 ECB meeting.  ECB Kazaks called for at least 50bps over the weekend, while ECB Rehn called for a significant hike and noted concern about the weak Euro.  Following on from ECB Knot and Holzmann on Friday, this suggests that the hawks want the option of a 75bps hike on the agenda for discussion.   The idea would be that a 75bps hike would get the ECB to neutral interest rates quicker.  The ability of the hawks to get their way in July is making the market nervous.

However, it is worth also listening to the more centrist ECB board members.  The Banque de France governor over the weekend noted that the ECB must show determination but avoid brutal interest rate moves and this should be seen as arguing against 75bps.  Additionally, ECB Schnabel noted that the ECB need to act forcefully against the risk of inflation expectations becoming destabilized citing concerns that the right tail of inflation expectations had been getting bigger. Some emphasis in the speech was placed on 3 year ahead consumer median expectations being at 2.8% and the mean at 4.6%. However, she did note that the median among professional economists had only crept up to 2.2%, while we would note that 10yr breakeven inflation at 2.5% (Figure 1) are not unstable.

ECB Lane speech on Monday appears to be more consistent with 50bps than 75bps.  Two key elements to highlight in the speech (here).  Firstly, he noted the desire for a steady pace in moving to the terminal policy rate. While senior ECB officials have been reluctant to say what this it is seen to be around 1.50% and the repo rate (currently 0.50%) could reach that level with 50bps in September and 25bps in November/December. Secondly, that in his view that long-term inflation expectations remain close to 2%.While he is on the dovish side of the spectrum at the ECB, this would provide additional support of the idea of a 50bps hike at the September 8 ECB meeting. 

Additionally, high inflation in the EZ needs to be seen in context, as the feedthrough of sky high gas prices has been an important factor and broad based inflation is less noticeable than the U.S.  The Euro weakness concerns also appears overdone, both given the more limited effect on import prices than gas and as the broad Euro TWI is not weak (here). It is also worth noting that ECB officials understand that they are facing a worse economic situation with higher inflation but the prospect of recession. The latter is not yet reflected in ECB staff forecasts and will argue against too aggressive action at the September meeting, while it is also worth noting that the ECB has opportunities to adjust official rates in November and December and could achieve neutral policy rates by 50bps in September followed by hikes in the subsequent meetings. Finally, a minority in the council wanted 25bps in July (here) rather than 50bps and they are likely to resist the idea of a 75bps hike.  Our forecast is for a 50bps hike at the September 8 meeting.

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I, Mike Gallagher, the lead analyst declare that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further declare that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.